Deregulation of Savings Banks' Deposit Interest Rates

Summary

This Forum of Free Enterprise booklet records the panel discussion at the 7th M. R. Pai Memorial Award function held in Mumbai on 7 July 2011, hosted by the All India Bank Depositors’ Association (AIBDA) and the Punjab and Maharashtra Cooperative Bank, plus three supporting annexures. Three former Deputy Governors of the Reserve Bank of India — Usha Thorat, Kishori J. Udeshi and S. S. Tarapore — respond to the RBI’s April 2011 Discussion Paper on deregulation of the savings bank (SB) deposit interest rate, which had been administered at 4 per cent since May 2011 (3.5 per cent before that). All three agree that deregulation is overdue, that the question is no longer whether but when and how, and that the present moment — with inflation high and the term structure already deregulated since the 1990s — is right. They argue for a phased approach with a regulator-prescribed floor rate, uniform monthly interest application, and clear safeguards for rural, pensioner and small depositors. The volume’s argumentative centre is that small depositors have been silently taxed by a regulated 4 per cent ceiling against high inflation, and that market-based pricing — supervised but not capped — is the cure. Annexures I and II reproduce AIBDA’s initial and revised submissions to the RBI on behalf of depositors; Annexure III, a detailed analytical paper by Prof. Ashish Das of IIT Bombay, marshals data showing persistent negative real returns on SB accounts and dissects how the changeover to daily-balance interest calculation in April 2010, far from helping savers, was offset by RBI’s simultaneous cut in the prescribed rate.

Essays

Deregulation of Savings Banks’ Deposit Interest Rates

By Usha Thorat, Kishori J. Udeshi, S.S. Tarapore

Usha Thorat, then Director of the Centre for Advanced Financial Research & Learning and former RBI Deputy Governor, opens the panel by reframing the question. Whether to deregulate, she says, is no longer in dispute; only the timing and the safeguards matter, and a period of high inflation is the right moment to move because customers can switch banks freely if rates fall too low. She walks through the case for a temporary floor rate — banks compressed deposit rates well below 3.5 per cent in 2009–10 when liquidity was abundant, and the rural or uninformed semi-urban depositor cannot easily move funds — but adds that deregulation ‘fully’ may work better than experimenting with a floor, since the floor itself risks becoming a ceiling. She rejects the asset-liability-mismatch fear (a 1 per cent rate rise on SB accounts adds only about 25 bps to the cost of deposits), insists that any new charges on cheque-book or transactional facilities must satisfy the Sadasivan committee’s reasonableness, fairness, equity and transparency tests, and warns that the periodicity asymmetry — monthly rests on loans versus quarterly rests on deposits — needs regulator review.

• Deregulation is no longer a question of ‘whether’ but of timing and sequencing; high inflation makes 2011 the right window.
• A floor rate would prevent banks from pushing SB rates below 3.5 per cent during glut periods, as happened in 2009–10, but risks ossifying into a ceiling.
• The asset-liability-mismatch argument is overstated: a 1 per cent rise in SB rates only adds ~25 bps to overall deposit cost, on a ceteris paribus basis.
• Service charges on cheque-book and other facilities must follow the Sadasivan committee principles of reasonableness, fairness, equity and transparency.
• The asymmetry between monthly interest application on loans and quarterly rests on deposits needs regulatory correction.

All India Bank Depositors’ Association — Mumbai (AIBDA): Deregulation of Savings Bank Deposit Interest Rate — Submission to the RBI (Annexure I)

By All India Bank Depositors’ Association (AIBDA)

Kishori J. Udeshi, Chairman of the Banking Codes and Standards Board of India and former RBI Deputy Governor, frames the issue from three angles: encouraging household savings, deepening financial inclusion, and protecting depositors. She notes that the share of saving deposits to aggregate deposits has fallen from 24 per cent in 2005 to 22.1 per cent in 2009 and asks pointedly whether deregulation will help. Drawing on the experience of Indonesia and Malaysia, she argues that deregulation alone produces negative real returns unless paired with central-bank inflation-anchoring; the goal must be a sustained positive real interest rate. She accepts that competitive forces will sometimes push rates down — invoking the parable of a man satisfied with three chapatis a day not minding receiving them as halves on alternate days — and reminds her audience that the SB rate was 6 per cent as recently as 1992. Cross-subsidisation of cheque-book and ATM costs has gone on too long; depositors must accept higher transactional charges as the price of liberalised returns. She closes by reasserting the role of supervision (quoting John Crow at the C. D. Deshmukh Memorial Lecture) and by calling for the Deposit Insurance and Credit Guarantee Corporation to be empowered as a vigilant overseer.

• Saving-deposit share has dropped from 24 per cent (2005) to 22.1 per cent (2009); deregulation alone will not reverse this without inflation-anchoring.
• Indonesia and Malaysia show that deregulation without monetary discipline produces negative real returns.
• Decades of cross-subsidising cheque-book and ATM costs have unfairly burdened term-deposit and borrower customers.
• Depositors must shed the old assumption that basic banking should be free; product innovation will arrive only if rates and charges are both free.
• The DICGC needs broader powers and a more active role as ‘vigilant overseer’ of depositors’ interests.

Deregulation of Savings Bank Deposit Rates — A Revised Submission to RBI from AIBDA (Annexure II)

By All India Bank Depositors’ Association (AIBDA)

S. S. Tarapore — the third panelist and a long-time campaigner on the subject — narrows the focus to depositors’ rights and the mechanics of sequencing. He treats the April 2011 RBI Discussion Paper as a long-overdue admission that the case for deregulation is closed and time for action has come. He proposes that the RBI prescribe a range (4–5 per cent) for the SB rate in the second half of 2011–12, mandate uniform interest rest periods across all banks, and complete the process in rapid phased steps within the same year. He links the short-term anchor to the long-term yield curve by pointing out that the regulated SB rate of 4 per cent sits well below the bank-determined one-year deposit rate of 9 per cent or more, producing the perverse outcome that SB holders cross-subsidise term depositors and borrowers. Against the bank-lobby claim that freeing the SB rate will destroy financial inclusion and No-Frills accounts, he is scathing: deregulation cannot be used to sanctify predatory pricing, and the prevailing assumption that depositors will meekly accept low rates is itself the danger. He closes by invoking L. K. Jha’s old dictum that fair banking gives the highest possible rate to depositors and the lowest possible rate to borrowers, and calls on depositors to organise — comparing the RBI’s belated acceptance of deregulation to General George S. Patten’s ‘Lead, follow or get out of the way’.

• Tarapore proposes a deregulated SB rate range of 4.0–5.0 per cent in the first half of 2011–12, completed in rapid phased steps that same year.
• Uniform interest application frequency must be mandated across banks; no discrimination by depositor size or location.
• Holding SB rates at 4 per cent while one-year term rates exceed 9 per cent forces SB holders to subsidise borrowers and term depositors.
• The ‘financial inclusion will collapse’ argument from banks is rejected as predatory rhetoric, not policy.
• Depositors are the legitimate owners of banks and must be prepared to organise — Tarapore calls for a ‘depositors’ revolt’ if their rights continue to be ignored.

Savings Bank Accounts - Interest Rate Deregulation (Annexure III)

By Ashish Das

Annexure I reproduces the All India Bank Depositors’ Association (AIBDA) submission to the RBI on the Discussion Paper. The submission situates the SB-rate issue inside two decades of gradual interest-rate deregulation — completed for term deposits by October 1997 — and argues that continued regulation of the SB rate has deprived depositors of market returns and created complacency among banks, who have come to treat the captive 40 per cent (CASA) of low-cost deposits as a ‘virtually perpetual basis’ funding source. AIBDA insists deregulation is necessary to complete the liberalising arc, to inject healthy competition, and to protect small consumers. It cautions, however, that special groups — senior citizens, pensioners and rural savers who find it difficult to switch banks — need a floor rate as a permanent protective feature, possibly with an extra 50 basis points above the floor.

• Term and fixed-deposit rate deregulation was completed by RBI in October 1997; SB rate alone has remained regulated, at 3.5 per cent since 2003 and 4 per cent since May 2011.
• Banks have built complacency around the captive 40 per cent CASA share that funds them at administered low cost.
• AIBDA recommends immediate deregulation but with an RBI-prescribed floor rate retained as a permanent protection.
• Senior citizens, pensioners and rural savers should receive an additional 50 basis points or higher above the floor, given their reduced ability to switch banks.

Essay 5

Annexure II is AIBDA’s revised submission, prepared after consultations with Deputy Governor Subir Gokarn and after taking on board feedback from individual bankers and the Indian Banks’ Association. It evaluates five policy options — no floor or ceiling, ceiling only, floor only, fixed floor and ceiling, and different floor and ceiling — and recommends a regulated floor (to protect small depositors) with a ceiling abandoned. AIBDA proposes a concrete formula: the floor rate should be pegged at half the repo rate rounded up to the nearest whole percentage, revised only when the repo rate moves by 200 basis points or more, and applied with monthly interest computation. A historical back-test from 2001 to 2011 shows that this formula would have tracked the regulator-fixed SB rate to within about 25 basis points on average. AIBDA also presses RBI to mandate transparent, reasonable service charges so that what banks gain on the ceiling-free rate side is not silently clawed back through opaque fees.

• Five regulatory options are weighed; AIBDA endorses ‘floor only’, with the ceiling abolished.
• Proposed floor formula: half the repo rate, rounded up to the nearest whole percentage, revised only on 200-bp repo moves.
• Historical back-test (2001–2011) shows the proposed floor would have tracked the RBI-fixed SB rate to within ~25 basis points.
• Interest application frequency should be made monthly as a first step toward simple, transparent net returns.
• Service charges must be regulated for reasonableness so that liberalised returns are not clawed back through opaque fees.

Essay 6

Annexure III is an analytical paper by Ashish Das, Professor of Statistics at IIT Bombay, that puts numbers behind the panel’s arguments. He shows that scheduled commercial banks held Rs. 492 million SB accounts (about 74 per cent of all deposit accounts) as of March 2009, that the SB rate has been downward-sticky despite favourable conditions for raises, and that the April 2010 shift to daily-balance interest computation — widely sold as a depositor win — was offset within months when RBI cut the prescribed rate from 4 per cent to 3.5 per cent and produced negligible net gains. He documents real SB returns turning persistently negative from 2003 onward (with the brief 2009 deflation a transient exception) and computes that the spread between declared nominal rates and effective rates of interest (using older calculation methods) was about 80 basis points until April 2010. He critiques RBI’s discretionary changes in interest application frequency on cash-reserve balances, RBI advances and public lending — each tilted in favour of banks — and argues that the deregulation of service charges, without standards on transparency, has shifted further surplus to bank profit margins. In the rendered pages his prescriptions cluster around three asks: deregulate the SB rate immediately, mandate monthly interest application as a transparency baseline, and discourage paper-based transactions through differentiated pricing rather than penalty fees.

• As of March 2009, scheduled commercial banks held about 492 million SB accounts — roughly 74 per cent of all deposit accounts.
• The April 2010 shift to daily-balance interest computation was offset by RBI’s near-simultaneous rate cut from 4 per cent to 3.5 per cent, yielding little net gain to depositors.
• Effective SB rates were typically about 80 basis points lower than declared rates under the pre-April-2010 method, due to month-minimum-balance computation.
• Real SB returns turned and stayed negative from 2003 onward (with brief 2009 exception), pinching small savers who lack bargaining power.
• RBI’s discretionary changes in interest application frequency on CRR, repo and bank loans have systematically favoured banks over depositors.
• Deregulated service charges, without transparency standards, have widened bank net interest margins rather than passing benefits to savers.